FALL 2016 EDITION
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GLOBAL ALL ASSET PORTFOLIOS
INVESTMENT
INNEALTA CAPITAL
TEAM
We are a quantitative asset manager specializing in risk-managed, global investment
solutions implemented via exchange-traded funds. We aim to produce well diversified
portfolios that exhibit high risk-adjusted returns in varying market environments.
CHIEF INVESTMENT OFFICER
Experience:
For over a decade, Innealta Capital has advised and managed
global investment portfolios of exchange traded funds. Our multidisciplinary team
possesses several advanced degrees, including PhD, MBAs, and MS from top
academic institutions. Our portfolio managers have an average of thirteen years of
industry experience.
Quantitative Framework:
Leveraging years of research, our proprietary
rules-based framework was initiated in 2005 and continues to parse and systematically
analyze hundreds of macroeconomic, corporate, and behavioral variables across many
asset classes to forecast asset returns and volatility
Process: Our quantitative framework informs our process. We apply a repeatable
process that merges proprietary forecasts with portfolio optimization, trade cost analysis,
and risk monitoring. Compared to baskets of individual securities, exchange-traded
funds offer several advantages including transparency, liquidity, and cost efficiency.
Diversification: Financial research has shown that diversification increases
risk-adjusted returns. Our Global All Asset Portfolios allocate across the six major asset
classes to improve diversification compared to a typical equity and bond portfolio.
Downside Protection: The Global All Asset Portfolio allocates across equity,
fixed income sovereign, fixed income credit, foreign exchange, commodity, and real
estate markets. This flexibility has historically provided improved capital protection.
Vito Sciaraffia, PhD // Chief Investment Officer
• PhD in Business, MS in Business, and MA in Mathematics from the University of California at Berkeley
• MBA and MF from the University of Chile and BS in Economics from the Catholic University of Chile
• Prior employers were Dimensional Fund Advisors, Citigroup, and JPMorgan
• Former Assistant Professor of Finance at the McCombs School of Business at The University of Texas at Austin
PORTFOLIO MANAGERS
Joshua Kocher // Portfolio Manager
• MBA in Finance from Columbia University and BS in Chemical Engineering from the University of Virginia
• Prior employers were MKP Capital, Credit Suisse, and Susquehanna Investment Group
• Thirteen years of industry experience as proprietary trader, associate portfolio manager, and portfolio manager
Jason Clark, CFA // Portfolio Manager
• BS in Finance from the University of West Florida
• Prior employers were A.G. Edwards, Edward Jones, and the United States Navy
• Fifteen years of industry experience as equity research analyst, fixed income trader, and portfolio manager
RESEARCH TEAM
Ray Chen // Quantitative Research Analyst
• MS in Statistics from Rice University and BS in Physics from Michigan State University
• Prior employer was Merrill Lynch
Aaron Steinman // Research Analyst
• MS in Finance and a BA in Economics from The University of Texas at Austin
• Prior employer was Durbin Bennett Peterson – Private Wealth Management
Chris Quigley // Research Analyst
• BA in Economics from the University of Southern California
• Seven years of industry experience with AFAM Capital
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QUANTITATIVE
FRAMEWORK
Innealta Capital utilizes a quantitative framework, robust enough to handle hundreds of different variables, yet flexible
enough to adapt to changing market conditions. The framework parses through hundreds of macroeconomic, corporate,
and behavioral variables to forecast asset returns and volatility. All variables are based on economic intuition and
backed by rigorous academic evidence. To evolve with changing market conditions, the Investment Team constantly
researches the effectiveness of new variables and new methods. Additionally, the team periodically reviews academic
and practitioners’ advancements, and when necessary, updates its models. Thus, as the framework revises its forecasts,
the Innealta Capital Investment Team adjusts the portfolio accordingly.
INNEALTA
PROCESS
We optimize the portfolio to account for revised forecasts, portfolio constraints, the evolving ETF universe, and
trading costs. The firm then executes through numerous broker dealers in order to minimize transaction costs
and dependency on any one relationship. On a daily basis, the firm monitors the framework’s forecasts, the
universe of global asset performance, and the portfolios’ performance. As markets evolve, we evaluate our
experiences and the performance of our framework to refine our process.
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ASSET CLASS
CORRELATION
ASSET CLASS
The first building block of a better portfolio requires finding assets with varying correlations. Correlations can vary both
within and across asset classes over time. The grid below shows the ten year observed correlations across a sample set
of the six major asset classes as of June 31, 2016. Per the aforementioned asset class intuition, certain asset class pairs
tend to correlate more with each other, such as foreign exchange to fixed income sovereign and equity to fixed income
credit. Not shown, but equally important, is the time-varying nature of correlations. The team tracks, estimates, and uses
these correlations as part of building diversified portfolios within the Global All Asset strategies.
INTUITION
The Global All Asset (GAA) strategies provide exposure across six major assets classes: equity, fixed income sovereign,
fixed income credit, commodities, foreign exchange, and real estate. Widening the scope of potential investments provides the opportunity to spread risk across different asset classes and geographies. The Innealta quantitative framework
analyzes the variables relevant to each sector and sub-sector within a given asset class, and provides the Investment
Committee insight on the various inter-asset relationships, intra-asset relationships, and the reward to risk profile.
The graphic below displays a stylized view of the GAA’s asset class universe and a sample of the intuition behind how
assets interrelate. The typical investor concentrates his/her portfolio within equity and fixed income investments. That
approach excludes opportunities in other asset classes that over time may provide higher risk-adjusted returns. For example, fixed income credit and equity relate based on corporate capital structure. From 2010 to 2015, the U.S. high-yield
credit market generated a higher risk-adjusted return than the S&P 500*. The Global All Asset portfolios account for the
complex relationships between asset classes and provide solutions that maximize return potential.
* Total return analysis from 01.01.2010 to 12.31.2015 conducted by Innealta Capital using the total return series of the S&P 500 Index and the The Markit iBoxx USD Liquid High Yield Index. Data provided by FactSet
Research Systems Inc.
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SOURCE: Innealta Capital using data from Bloomberg
Data from 06.30.06 to 06.30.16. Correlation values calculated using weekly data.
Please see important notes section for asset descriptions.
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WHY ACTIVE
MANAGEMENT
WHY PORTFOLIO
DIVERSIFICATION
Investing directly in a pool of varying asset classes creates an opportunity to capitalize on the significant return dispersion
observed in global markets. Shown below are the top five and bottom five performing asset class performers for a given
year using the aforementioned asset class universe. With the benefit of complete hindsight, the return potential of buying
the winners and avoiding the losers is large. In addition, the constituents of the top or bottom five performers change over
time, implying that a multi-asset portfolio could benefit from proper active management. Innealta Capital’s quantitative
framework parses the hundreds of variables necessary to continuously analyze each of these markets and informs the
Investment Team about potential opportunities.
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Compared to a binary portfolio of equity and fixed income instruments, the Global All Asset strategies have a higher potential return per unit of risk through the benefit of diversification. The illustration below, commonly known as the Markowitz efficient frontier, shows the resulting volatility by optimizing the underlying assets within the portfolio for a fixed return.
The “concentrated portfolio” contains a basket of the S&P 500, U.S. 2 year Treasuries, and U.S. 5 year Treasuries. The
“diversified portfolio” widens the options to include fixed income credit, foreign exchange, real estate, and commodities.
At all points, the diversified portfolio delivers a higher return per unit of risk than the U.S. domestic portfolio.
SOURCE: Innealta Capital using data from Bloomberg.
The above chart uses daily total return data denominated in USD from 06.30.06 to 06.30.16. Each point along the efficient
frontier corresponds to an optimization that maximizes return for a given volatility by changing the asset weights. Short
selling is prohibited in the analysis. Please refer to important notes for additional information about basket constituents.
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SOURCE: Innealta Capital using data from Bloomberg.
Total return data denominated in USD from 12.31.05 to 12.31.15.
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IMPORTANT NOTES
Innealta Capital is a division of AFAM Capital. AFAM Capital is a Registered Investment Advisor, is editor of The Prudent Speculator newsletter and is the
Investment Advisor to certain proprietary mutual funds and individually managed client accounts. Registration of an investment adviser does not imply any
certain level of skill or training.
The Global All Asset Conservative, Global All Asset Moderate and Global All Asset Growth Composites include discretionary portfolios using the tactical ETF
Global All Asset strategies that are based on a quantitatively driven, tactical asset allocation approach that apportions portfolio assets to five individual equity
classes based on the specific risk/reward characteristics of each. Dollars not allocated to equities are invested in a basket of primarily fixed-income ETFs.
There is no assurance that investment objectives will be met. The ETFs that are included in the portfolio change over time. The U.S. Dollar is the currency used to
express performance. Performance is presented net of management fees and includes the effects of trading costs and reinvestment of all income. Net of fee performance was calculated using actual management fees charged to the client. Policies for valuing portfolios, calculating performance, and preparing compliant
presentations are available upon request. Actual Investment management fees will vary, beginning at 1.5% per annum. Our full management fee schedule is
described in more detail in Form ADV Part 2A
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
Any investment is subject to risk. Exchange traded funds (ETFs) are subject to risks similar to those of stocks, such as market risk, and investors who have their
funds invested in accordance with the portfolios may experience losses. Additionally, fixed income (bond) ETFs are subject to interest rate risk, which is the risk
that debt securities in a portfolio will decline in value because of increases in market interest rates. Real Estate ETFs are subject to the risk that real estate stocks
will decline because of adverse market conditions for the real estate indusdtry or declines in real property values. For more information on the risks associated
with investment in ETFs, please refer to AFAM Capital’s Form ADV Part 2A.
DOWNSIDE
PROTECTION
Global All Asset Benchmarks
Since inception, the Global All Asset portfolios have historically provided superior downside protection versus
the broad domestic equity markets. The figure below depicts the maximum drawdown observed within each
of the stated calendar years for the Global All Asset Moderate strategy and the S&P 500 Index, which is widely accepted as a measure of overall US equity market performance. Maximum drawdown can be considered
a “pain” index and is an indicator of downside risk over a specified time period. Calendar Year Maximum
Drawdown, displayed below, measures the largest single drop from peak to bottom in the value of the portfolio, before a new peak was attained – within that same calendar year.
2010
2011
2012
2013
2014
2015
2016
0%
-2%
-5.6%
-6.6%
-6.7%
-8%
-9.5%
-9.6%
-6.5%
-7.3%
-9.3%
-10.2%
-10.3%
-12.0%
-12%
-14%
-18%
The GAA Growth benchmark is 28% Russell 3000 Total Return Index / 32% MSCI AC World Daily TR Net Ex USA USD / 8% Dow Jones Global Select Real Estate
Securities Total Return Net Index / 12% S&P GSCI Total Return CME / 20% Barclays GlobalAgg Total Return Index Value Unhedged USD. Prior to that, the
benchmarks consisted of 40% MSCI ACWI NR / 60% Barclays Agg (Conservative), 60% MSCI ACWI NR / 40% Barclays Agg (Moderate), and 80% MSCI ACWI
NR / 20% Barclays Agg (Growth).
The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. The MSCI World ex USA Index captures large- and mid-cap representation across 22 of 23 Developed Markets (DM) countries*–excluding the United
States. Net total return indexes reinvest dividends after the deduction of withholding taxes, using (for international indexes) a tax rate applicable to non-resident
institutional investors who do not benefit from double taxation treaties. The Barclays Global Aggregate Index is a flagship measure of global investment
grade debt from twenty-four different local currency markets. This multi-currency benchmark includes fixed-rate treasury, government-related, corporate and
securitized bonds from both developed and emerging markets issuers. The Dow Jones Global Select Real Estate Securities Index (RESI) represents
equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded globally. The S&P GSCI Total Return Index in USD is
widely recognized as the leading measure of general commodity price movements and inflation in the world economy. Index is calculated primarily on a world
production weighted basis, comprised of the principal physical commodities futures contracts.
Asset Class Correlation Chart Notes
-6%
-16%
The GAA Moderate benchmark is 21% Russell 3000 Total Return Index / 24% MSCI AC World Daily TR Net Ex USA USD / 6% Dow Jones Global Select Real
Estate Securities Total Return Net Index / 9% S&P GSCI Total Return CME / 40% Barclays GlobalAgg Total Return Index Value Unhedged USD.
Blended benchmarks are rebalanced quarterly. It is not possible to invest directly in an index.
-4%
-10%
The GAA Conservative benchmark is 14% Russell 3000 Total Return Index / 16% MSCI AC World Daily TR Net Ex USA USD / 4% Dow Jones Global Select Real
Estate Securities Total Return Net Index / 6% S&P GSCI Total Return CME / 60% Barclays GlobalAgg Total Return Index Value Unhedged USD.
-15.6%
-15.5%
-18.6%
-20%
GLOBAL ALL ASSET MODERATE PORTFOLIO
S&P 500 TR INDEX USD
SOURCE: Innealta Captial using data from FactSet Research Systems.
The Dow Jones U.S. Select REIT Index intends to measure the performance of publicly traded REITs and REIT-like securities. The iBoxx USD Liquid
Investment Grade Index is an index composed of U.S. dollar-denominated, investment-grade corporate bonds. The iBoxx USD Liquid High Yield Index
is an index composed of U.S. dollar-denominated, investment-grade corporate bonds. U.S. benchmark bond 2 year refers to The Merrill Lynch 2-year U.S.
Treasury Futures Total Return Index which measures the performance of a fully collateralized rolling 2-year U.S. Treasury futures position. U.S. benchmark
bond 5 year refers to The Merrill Lynch 5-year U.S. Treasury Futures Total Return Index which measures the performance of a fully collateralized rolling
5-year U.S. Treasury futures position. U.S. benchmark bond 10 year refers to The Merrill Lynch 10-year U.S. Treasury Futures Total Return Index which
measures the performance of a fully collateralized rolling 10-year U.S. Treasury futures position. U.S. benchmark bond 30 year refers to The Merrill Lynch
30-year U.S. Treasury Futures Total Return Index which measures the performance of a fully collateralized rolling 30-year U.S. Treasury futures position. The
MSCI AC Asia ex Japan Index captures large and mid cap representation across 2 of 3 Developed Markets countries (excluding Japan) and 8 Emerging
Markets countries in Asia. The MSCI Emerging Markets Index captures large and mid cap representation across 23 Emerging Markets (EM) countries.
The MSCI Frontier Markets Index captures large and mid cap representation across 23 Frontier Markets (FM) countries. The Japan Nikkei 225 is a price
weighted index of the 225 top-rated companies listed in the First Section of the Toyko Stock Exchange. The S&P GSCI Total Return Index in USD is widely recognized as the leading measure of general commodity price movements and inflation in the world economy. Index is calculated primarily on a world production
weighted basis, comprised of the principal physical commodities futures contracts. The S&P 500 Index measures the performance of the large capitalization
sector of the U.S. equity market and is considered one of the best representations of the domestic economy. The Eurostoxx 50 is a market capitalization weighted index of the leading 50 stocks covering Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain.
USDAUD denotes the amount of Australian Dollars that 1 U.S. dollar can purchase. USDCAD denotes the amount of Canadian Dollars that 1 U.S. dollar can
purchase. USDCHF denotes the amount of Swiss Francs that 1 U.S. dollar can purchase. USDEUR denotes the amount of Euros that 1 U.S. dollar can purchase.
USDGBP denotes the amount of GBPs that 1 USD can buy. USDJPY denotes the amount of Japanese yen that 1 U.S. dollar can purchase.
Why Portfolio Diversification Chart Notes
The “concentrated portfolio” refers to the S&P 500 Index, U.S. benchmark bond 2 year, U.S. benchmark bond 5 year, U.S. benchmark bond 10 year, and U.S.
benchmark bond 30 year. The “diversified portfolio” excludes the S&P 500 and includes all other indices mentioned in the “Asset Class Correlation Chart Notes”
above.
Why Active Management Chart Notes
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Important note: Chart depicts the maximum drawdown within a calendar year to show an important aspect of
the strategy goal: risk mitigation. There is no guarantee this goal will be met. Past performance is no guarantee
of future results. Performance is shown net of fees and expenses. The information above is not intended to
be representative of performance versus the benchmark for this portfolio, a blend of 21% Russell 3000 Total
Return Index / 24% MSCI AC World Daily TR Net Ex USA USD / 6% Dow Jones Global Select Real Estate
Securities Total Return Net Index / 9% S&P GSCI Total Return CME / 40% Barclays Global Aggregate Total
Return Index Value Unhedged USD. Factsheets for the portfolio include this information and are available at
our website and upon request.
The chart contains references to individual asset classes that are represented by the indices mentioned and defined in the “Asset Class Correlation Chart Notes”.
Performance calculation details are available upon request.
308-AFAM-09/15/2016
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Contact Innealta Capital at
855.994.2326
12117 FM 2244
Building 3, Suite 170
Austin, Texas 78738
www.innealtacapital.com